The IRS has issued final regulations under Section 446 (T.D. 9774) that provide a simplified method of accounting for gains and losses on shares in a money market fund (MMF). The final regulations generally adopt, with some modifications and clarifications, proposed regulations (REG-107012-14) issued in July 2014.
An MMF is a type of investment company registered under the Investment Company Act of 1940. Unlike other types of mutual funds, MMFs have historically maintained stable prices for their shares, typically $1 per share. The types of securities that MMFs are permitted to hold and their share-pricing and valuation methods have made these $1 constant prices possible.
The perceived safety and simplicity of MMFs have led to their use as cash management vehicles for investors. It’s common for investors to purchase and redeem MMF shares frequently. Because MMFs have historically been issued and redeemed at the constant price of $1, MMF shareholders generally don’t realize gain or loss when they redeem an MMF share.
But several years ago, the SEC issued regulations that will change how certain MMFs (floating MMFs) are priced when they’re issued and redeemed. The changes require floating MMFs to issue and redeem shares at a price that changes regularly, which means that shareholders will now typically recognize gain or loss on redemptions of floating MMFs. Certain government-security-focused MMFs and MMFs that allow only natural persons as beneficial owners (stable MMFs) may continue to use the existing pricing method.
The SEC received comments expressing concern that the frequent purchases and redemption of floating MMF shares combined with relatively small changes in share values could result in tax compliance burdens that are disproportionate to the amount of gain or loss at issue. So the IRS’s proposed regulations in 2014 created a simplified method of accounting for gains and losses on shares in a floating MMF. The newly issued final regulations adopt the proposed regulations with modifications. For example, they allow the simplified method of accounting for both floating MMFs and stable MMFs.
Specifically, the newly issued Treas. Reg. Sec. 1.446-7(c) allows taxpayers to use the “NAV method” to determine gain or loss for a taxable year regarding shares of an MMF. The NAV method computes net gain or loss for each “computational period” equal to the ending value of shares of a particular MMF, minus the starting basis of such MMF shares, minus “net investment” in such MMF during such computational period. A computational period may be the taxable year or a shorter period (for example, a month or a week) subject to certain requirements.
A taxpayer’s gain or loss related to floating MMF shares under the NAV method is capital if the underlying floating MMF shares would otherwise give rise to capital gain or loss. Similarly, a taxpayer’s gain or loss related to floating MMF shares under the NAV method is ordinary if the underlying floating MMF shares would otherwise give rise to ordinary gain or loss. The IRS also stated that no return of information is required with regarding a sale of shares of an MMF.
The regulations are effective for taxable years ending on or after July 8, 2016, but taxpayers may rely on either the final regulations or the proposed regulations for any taxable years ending on or after June 28, 2014, as long as they begin before July 8, 2016.
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